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Abstract

Technological developments in securities markets, most notably high frequency trading, have fundamentally changed the structure and nature of trading over the past 50 years. Policymakers both domestically and abroad now face many new challenges impacting the secondary market’s effectiveness as a generator of economic growth and stability. Faced with these rapid structural changes, many are quick to denounce high frequency trading as opportunistic and parasitic. This article, however, instead argues that while high frequency trading presents certain general risks to secondary market efficiency, liquidity, stability, and integrity, the practice encompasses a wide variety of strategies, many of which can enhance, not inhibit, the secondary trading market’s core goals. This article proposes a regulatory model aimed at maximizing high frequency trading’s beneficial effects on secondary market functions. The model’s foundation, however, requires information. By analyzing more data on how high frequency traders interact with markets, regulators can assess the viability and scope of other potentially worthwhile measures targeting more general market threats. Likewise, regulators can determine who is in the best position to bear supervisory responsibility for particular trading activities: agencies, exchanges, traders, or some combination thereof. Crucially, the model also calls on regulators to share information on a global scale: trading no longer only affects a single exchange, a single asset class, or even a single country. By sharing information, global regulations become more informed, secondary market stability is enhanced, and regulatory arbitrage is minimized. In short, high frequency trading can be a force for good, but a principled and coordinated effort is required to ensure it fulfills that potential.

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